Funding Currency

DEFINITION of 'Funding Currency'

The funding currency is one that is exchanged in a currency carry trade transaction. A funding currency typically has a low interest rate. Investors borrow the funding currency and take short positions in currencies with higher interest rates.

Countries of funding currencies often have high levels of central bank assets that have engaged in bondbuying programs.

BREAKING DOWN 'Funding Currency'

The Japanese yen has historically been popular as a funding currency among forex traders because of its low interest rate. For example, a trader will borrow Japanese yen and purchase a currency with a higher interest rate, such as the Australian dollar of New Zealand dollar. Other funding currencies include the Swiss franc, and in some parts, the U.S. dollar.

During times of high optimism and increasing equity prices, funding currencies will under perform because investors are willing to take on more risk. On the other hand, during financial crises, investors will rush to funding currencies because they are considered safe haven assets.

For example, in the 12 months before the Great Recession, the Australian dollar and New Zealand dollar appreciated by more than 25 percent against the Japanese yen. However, from mid-2007 as the crisis began to unfold these carry trades were unwound and investors dumped the higher yielding currencies in favor of the funding currency. Both the Australian dollar and New Zealand dollar lost more than 50 percent of its value against the Japanese yen during the recession.